The Federal Open Market Committee lowered its target for the federal funds rate by 75 basis points to 2.25%.
In the published statement the Committee members commented on the cut of key interest rates in the following way: “Recent information indicates that the outlook for economic activity has weakened further. Growth in consumer spending has slowed and labor markets have softened. Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters. Today’s policy action, combined with those taken earlier, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain”. At the end of the press-release they added again that they will continue assessing the effects of these and other developments on the economic prospects and will take the needed measures to foster price stability and sustainable economic growth (appendix 1).
In regard to prices FOMC members opinions changed slightly “Inflation has been elevated, and some indicators of inflation expectations have risen. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully”. Of no small importance is the fact that two of the Committee members voted against, preferring a less aggressive cut.
Committee members decided to cut federal funds rates for the sixth consecutive time. Aggressive actions of the Fed were caused by the crisis in the US real estate market, tightened credit conditions for the private sector, huge losses of investment banks and sell-off in stock market. In the context of these developments two year Treasury bond yield dropped down to 1.35%, which has been the lowest level since June 2003 (chart 1).
The tension on financial market remains high following the unwillingness of the banks to lend each other and “freeze” bonds market, backed by Subprime and Alt-A mortgages. Since the companies, providing such loans, are unable to finance their liabilities through fixed income market, there is still a cash deficit and discredit towards each other in the financial market.
Five leading central banks realized coordinated intervention and provided liquidity for 28 days to satisfy the demand for short term liquidity. For that the Fed lent 36bln USD to the European Central Bank (30bln) and Swiss National Bank (6bln). This loan was meant for satisfying the needs of European banks in USD. BOC and BOE intervened without the assistance of FED. Moreover, the Fed lent 200bln of Treasury securities to primary dealers for 28 days by a pledge of mortgage backed securities. As Treasuries have highest liquidity it will give banks an opportunity to borrow by low rates.
Serious problems of Bear Stearns forced the Fed to reduce discount rate by 25 basis points on unscheduled meeting on March 16. The Committee members had an unscheduled meeting on a day off three decades ago.
These developments confirmed our opinion to the effect that the negative impact of credit crunch on economy will be significant, as long as the rise of real estate prices has been the main driver of the US economic growth in the last years (chart 2). According to some estimations the fall in housing prices by one dollar reduces personal expenditure from 7 to 8 cents. Moreover, there are the first signs of the ending of the four year rapid employment growth cycle. According to the published data wage growth is significantly reducing, whereas unemployment rate remains at low level.
Abrupt reduction of fixed investments has left a mark on real estate market and construction, in the form of downsizing workplaces, mortgage companies’ bankruptcy and negative sentiment regarding the perspectives of this sector’s further growth. Huge losses of investment banks “collapsed” the US stock market, the capitalization increase of the latter along with real estate market had a significant negative impact on the economic growth.
On the basis of these arguments we adduce an opinion that the reduction of federal funds rates will depend on two opposite factors: on the one hand these are oil, metal and wheat prices, and on the other hand - real estate market and personal expenditure data. We also assume that if the crisis in the real estate market negatively impacts growth pace of personal expenditure, Committee members will most likely have to shut their eyes to inflation and cut interest rates for providing inexpensive liquidity to the market. Since the condition of the economy has been worsening day by day, the Fed started to stimulate the economic growth. In this connection, we think, that federal funds rates will be lowered by another 25 or 50 basis points. Only the dynamics of commodity may mitigate the current pace of interest rates easing policy.
Appendix 1
US Federal Open Market Committee Statements
March versus January
FOMC Statement - March 18
Recent information indicates that the outlook for economic activity has weakened further. Growth in consumer spending has slowed and labor markets have softened. Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.
Inflation has been elevated, and some indicators of inflation expectations have risen. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully.
Today’s policy action, combined with those taken earlier, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will act in a timely manner as needed to promote sustainable economic growth and price stability.
FOMC Statement - January 30
Financial markets remain under considerable stress, and credit has tightened further for some businesses and households. Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labor markets.
The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.
Today’s policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.
US ECONOMIC INDICATORS
Chart 1
Source: Federal Reserve Systems, Bloomberg
Chart 2
Source: OFHEO
